Smart dividend plays for 2016

Well, she finally did it. Janet Yellen finally hiked the targeted fed funds rate from 0% to a whopping 0.25%.

But she also made it abundantly clear that she had no plans to raise it aggressively from here. Although we have officially achieved liftoff, rates will still be very low for a long time to come.

So, if you’re waiting for a 5% CD to help fund your retirement … let’s just say I hope you’re not holding your breath.

The bottom line is that income investors are going to need to look elsewhere in 2016 … and probably for several years to come. And one solid option is in monthly dividend stocks.


Cash Flow

The problem with traditional dividend stocks and bonds is that the cash flows are lumpy. Our expenses tend to be monthly, yet bond interest is generally paid twice per year and most dividends are paid quarterly.

But some of the very best dividend stocks are those that pay 12 times a year. While you should never buy a stock purely because of its payout schedule, I believe there is quite a lot to like about monthly dividend stocks.


When they commit to paying monthly, management is showing very ostentatiously that they are giving their shareholders what they want.

And for investors reinvesting their dividends, the monthly frequency means faster dividend compounding.

So with no further ado, let’s just into my favorite monthly dividend stocks for 2016.

EPR Properties (EPR)

I’ll start with a quirky stock that is something of a misfit in the REIT space: EPR Properties (EPR).

The persistent wailing and gnashing of teeth throughout 2015 over the Fed’s rate hike hit REITs particularly hard, and EPR was no exception.

Between late January and September, the stock lost 25% of its value, though it has been steadily gaining ground ever since.

EPR has an odd mixture of properties and focuses mostly on entertainment assets, such as movie theaters, ski parks and golf driving ranges. (“EPR” is short for “Entertainment Properties.”)

7% Clip

It also owns charter schools and child development centers. This makes it hard to compare EPR to peers, because frankly, it really doesn’t have any.

Over the past five years, EPR has grown its dividend at a nearly 7% clip. For a conservative REIT, that’s pretty good, and certainly better than the rate of inflation.

I don’t see a quarter-point Fed hike having much of an impact on EPR from here. Buy it for the monthly dividend and plan to hold on to it for a while, in my opinion.

Stag Industrial Inc (STAG)

Next up is Stag Industrial (STAG), a relatively small REIT with a market cap of about $1.3 billion. This makes STAG too small for the big institutional investors to buy but still big enough to be properly diversified.

There is a major advantage to being a regular, individual investor. We can buy outstanding stocks like STAG without having to worry about moving the market.

“STAG” is an acronym for “single tenant acquisition group,” and this sums up the growth strategy well.

Deep Portfolio

Stag buys standalone single-tenant properties in the light industrial space — things like warehouses and manufacturing facilities — that generally don’t need a lot maintenance.

STAG had a portfolio of 233 properties spread across 38 states as of December 31, and the majority of its tenants are investment-grade-rated. Furthermore, STAG is very well-diversified across its tenant base. Its largest tenant only accounts for 2.7% of its rental income.
STAG’s tenants are also well diversified across industry. The two largest industry concentrations — automotive and air freight — each account for only 12% of rents.

That’s a conservative profile, which is exactly what you want from one of your monthly dividend stocks, I believe.

STAG’s monthly dividend yields a whopping 7.6%, and STAG is a serial dividend raiser. STAG has only been trading since 2011, and it has already raised its dividend eight times.

Prospect Capital Corporation (PSEC)

Let’s take a break from REITs and take a look at another segment of the market that has gotten crushed this year mostly due to Fed fears: business development companies.

BDCs as a sector have been trading at discounts to their net asset values for well over a year now, though the mispricing only seems to be getting worse.

Prospect Capital (PSEC), which I recommended as my Best Stock for 2015, trades at an almost incredible 35% discount to book value. In theory, you could buy up the entire company, sell it off for spare parts, and walk away with a nice 35% profit.


Could Prospect Capital be inflating its book value? Sure. BDCs have a fair amount of wiggle room in how they report the values on illiquid holdings.

But even if book value were overstated by 5 to 10 percentage points — and I should be clear that I do not believe that to be the case – PSEC still is trading at a deep discount.

And there is the dividend. At current prices, PSEC’s monthly dividend yields a fat 15%.

Risk Dynamics

Yields that high don’t come without risk. Could it be that PSEC will be forced to slash its dividend if business takes a turn for the worse?

I suppose it’s possible. Current cash flows cover the dividend.

But with shares trading at such a deep discount, management has effectively lost the ability to raise new funds for growth via the capital market.

In the worst-case scenario, I suppose that Prospect and other BDCs could be forced to make the same ugly decision Kinder Morgan (KMI) did when it opted to slash its payout.

But the way I look at it, given that the stock is trading at just 65% of book value, there’s not a lot of risk in holding it at these prices. And, in my opinion, it’s not unrealistic to expect total returns of 100% or more over the next 12 to 24 months.

Leveraged ETF

The next recommendation is a mouthful: the UBS ETRACS Monthly Pay 2X Mortgage REIT ETN (MORL) MORL isn’t exactly a stock.

It’s a leveraged exchange-traded fund that tracks the performance of a basket of large mortgage REITs like Annaly Capital (NLY) and American Capital Agency (AGNC).

But because it’s leveraged, you get two times the yield and two times the market moves of the underlying basket.

In 2015, that wasn’t exactly a good thing. At one point in the year, MORL had lost nearly half its value in price terms (although the massive monthly dividend certainly eased the pain a little).

Book Value

Normally, I would avoid a leveraged ETF, as I find that the returns are rarely worth the risk taken. But in MORL, the cheapness of the mortgage REIT sector leads me to make an exception.

Annaly Capital trades for just 76% of book value, and American Capital Agency just 74%.

That’s crazy pricing given that the underlying holdings are real mortgage securities. Much of the rest of the sector trades at similar crazy discounts to book value.

Do these discounts guarantee that prices can’t go lower? Of course not. As John Maynard Keynes put it, the market can stay irrational longer than you can stay solvent.

But at these prices, I believe the potential downside  is limited. our downside is definitely limited.

Less Risky Alternative

If MORL is simply too volatile for you to stomach, try an unleveraged mREIT ETF like the iShares Mortgage Real Estate ETF (REM).

It doesn’t pay monthly like MORL, but it does sport a nice yield of nearly 15%.

Next up, we have the Cohen & Steers Limited Duration Preferred and Income Fund (LDP). LDP, like our mortgage REIT ETF, isn’t a stock. It’s actually a mutual fund that trades like a stock.

Closed-End Fund

LDP is a closed-end fund, and it’s very different from what you might be used to with your typical mutual fund.

In a traditional open-ended mutual fund, you send money directly to the manager (or your broker does) and they invest it on your behalf.

When you want to get your money back, the manager sells off some of their holdings (if they don’t have the cash on hand) and sends you the proceeds.

Money is constantly going into and out of the fund, and new shares are constantly being created and destroyed.

11% Discount

Well, that’s not how a closed-end fund works. Instead, there are a fixed number of shares that trade on the New York Stock Exchange. And that’s where it gets fun.

Closed-end funds often trade at large premiums or deep discounts to their underlying portfolio values.

At current prices, LDP trades at an 11% discount to its book value and yields more than 8%. Furthermore, the book value itself has been affected by Fed fears.

As the yields of virtually all non-Treasury debt have risen this year, so have the yields of the preferred stock in LDP’s portfolio.

As the credit markets return to something closer to “normal” in 2016, I expect LDP to benefit from both an improvement in book value and a narrowing of its wide discount.

LTC Properties Inc (LTC)

Let’s jump back to REITs and add one more to our list of monthly dividend stocks: health and senior living REIT LTC Properties Inc (LTC).

The ticker symbol really says it all. “LTC” stands for “long-term care,” one of LTC’s property specialties that makes the REIT a viable way to play the aging of the baby boomers.

LTC’s portfolio is concentrated in skilled nursing, assisted living, independent living and memory care properties, though roughly a fifth of the portfolio is invested in mortgages backed by these kinds of properties. This makes LTC something of a hybrid.

LTC currently sports a dividend yield of 5.2%. For a stock that has performed fairly consistently, I think that’s an attractive cash return and more than double the 10-year Treasury yield.

Realty Income Corp (O)

And finally, no list of monthly dividend stocks is complete without the “Monthly Dividend Company” itself, Realty Income (O).

I should be clear on something: Realty Income is not a bond. It is a stock with all of the risks that come with an investment in the stock market.

But that said, Realty Income is about as close to a bond as you can get while still being in the stock market. O stock pays its monthly dividend with the reliability of a Swiss watch, and its cash flows are supported by a portfolio of essential, recession-proof retail properties.

Smart Returns

This stock has made 545 consecutive dividend payments, and I cannot see anything short of nuclear Armageddon breaking that streak.

But while I consider Realty Income as safe as a bond, its returns are competitive with a growth stock. Since going public more than 20 years ago, Realty Income has enjoyed compounded total returns of 16.6% per year.

And it has also raised its dividend for 73 consecutive quarters.

I have shares of Realty Income that I keep in my IRA that I have pledged never to sell. My dividends are set to automatically reinvest, and I never look at the account.

I intend to leave these shares to my kids someday, and if they’re smart they’ll do the same for their own children.

I can’t say this about too many companies, but I expect

Realty Income to still be paying its monthly dividend long after I’m dead and in the ground.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management.  As of this writing, he was long EPR, LDP, LTC, MORL, O, PSEC and STAG.

Photo credit: DonkeyHotey via Flickr Creative Commons
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